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Investing framework: Intelligence vs independence

Apr 21, 2008

In accomplishing any complex, goal oriented activity like playing a sport, learning a musical instrument or investing, there are two parallel requirements - that of technique and temperament. To use a cricketing analogy, it is said that while many hopefuls have the technique, only those with the necessary temperament to handle international cricket eventually make it. Similarly, anyone who has learnt a musical instrument knows that the knowledge of music theory and mechanics of the instrument is only part of the deal. It is equally important to have the requisite temperament to handle the frustrations unique to the endeavor at every stage. Similarly, there are two aspects to making investments- the technique of investing and the emotional temperament for investing. It has been our constant endeavour to assist you in the technique of investing through detailed research reports, recommendations and analysis of latest developments.

From this article onwards, we shall try to enumerate and address several issues with regard to investment temperament. We shall also touch upon areas where the technique of and temperament for investments fuse together and are inseparable.

Before we proceed, it may be noted that we shall keep the retail (equity) investor in mind for our discussions, i.e. one who prefers to take the investment decisions in stocks oneself.

Intelligence vs. Independence: Which is more important?

One of the persistent myths concerning investments is it requires a very high degree of intelligence, great mathematical dexterity, extraordinary understanding of business/economics or even special information unavailable to the general public.

How else does one explain the colossal industry employing armies of specialist money mangers/ analysts who use complex mathematical formulae, intricate models and chase every last conceivable bit of information? Doesn't the investment industry attract the best and the brightest, and always top the salary stakes during the placement season of prestigious B-schools?

The vast majority of the investment decisions affecting Indian stock market are by these brilliant investment professionals. Now, anyone following what has happened in stock markets over the past year would wonder if apparent intelligence really works when it comes to investing. Actually, this is not the first time that smart money turns out to be not so smart. Nor will it be the last.

We believe that independence might be more important than intelligence when it comes to investing. Warren Buffett has often said that success in investment doesn't correlate with one's ability to crack complex mathematical problems. He mentions that once you have ordinary intelligence, what you need is the temperament to control the urges that get other people into trouble in investing.

Independence is the cornerstone of such a temperament. Retail investors have the luxury of independence, which gives them a crucial advantage over "smart money", where it counts. Unlike the professional investors, there is no one breathing down their necks to measure short-term performance or dictating caps on what they can hold and to what limit. More importantly, there is no peer pressure to constantly conform to others' investment thesis. This independence means that retail investors can buy what they want, as infrequently as they want and hold for as long as they want. This is a crucial advantage, which alas is often unwittingly relinquished by them.

The first step towards developing a proper framework, then, is to always protect one's independence. For often, that's the one thing professional investors have in short supply.

We shall discuss the merits of a top down vs. a bottom up approach for investing in the next article.

Reading is an excellent way to develop one's investment framework. We urge you to refer to investment classics (books, articles and speeches) in the original.


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